Marking to Market

Margin Accounts and Marking to Market

Marking to market refers to the daily settling of gains and losses owing to flux in the market value of a given Futures position or other security. If the value of the underlying asset rises on a given trading day, the trader who bought (went long the position) profits. Conversely, if the value of the underlying asset drops on a given trading day, the trader who went short (sold) - profits at the expense of the counterparty. Typically, at the end of each trading day, the clearinghouse settles the difference in the value of the contract. (Real-time settlement will become increasingly feasible as server costs continue to decline and higher frequency settlement should help reduce default risk). Settlement can be achieved by mutually adjusting the margins posted by the corresponding counterparties. The operation of the margin accounting based on marking to market produces a is a key collateral heuristic that reduces agency problems at a relatively small cost. The effect of Dodd Frank (2010) and EMIR (2012) will be to impose on OTC markets these dynamics that clearinghouses provide on organised Futures Markets. Below, we take the example of margin account developed in John C. Hull and we discuss likely impacts.